Monday, September 14, 2015

Connecting the Dots - 9/14/15

As traders stroll and stumble into another marque event at the Fed this week, we thought we would do a quick follow-up on a few markets we continue to keep close tabs on. 

- Presented in no particular order from previous notes.

The US dollar index continues to chip lower, loosely following the breakdown from the 1985 secular high. Similar to the market reflex in yields following the suggestion and commencement of the taper that drove the 10-year yield to a relative performance extreme in late 2013 - and traders to infer a continuation of like-conditions throughout much of 2014 (see Here); the move in the dollar over the past year has been equally severe with convictions of further strength, just as strong. Although event risk from the four largest central banks (Fed, ECB, BOJ & PBOC) remains high coming into the fall, we still expect the dollar to step lower over time as greater clarity on policy encourages listing positioning to sell the news. For more recent thoughts on the dollar, see Here

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Coming into the Fed decision Thursday, gold is testing the lows from this summer's swoon, similar to the performance pattern of the secular low achieved subsequent to the first rate hike in June 1999. At $1100/oz, we like gold - rate hikes and all. For recent thoughts on gold, see Here
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With the recent breakdown in global equity markets, the Japanese yen recaptured and now sits on its nearly 30 year trend line support. Over the course of this year, we have waited for the negative correlation extreme that has been in place over the past three years between the Nikkei and yen to reverse course (Figure 11) - and continue to like the Nikkei's longer-term prospects. Nevertheless, we suspected the shift would come with greater strain on equities; similar (but inverse, Figures 12-13) to how the negative correlation extreme between the Nikkei and yen resolved in 2009. As such, we have approached a position in the yen as a hedge to any equity exposure in Japan. Per the 2009 comparative (Figure 13) pattern, the Nikkei would have another minor leg down, before recapturing upside momentum into 2016. 
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Bonds continue to make the turn lower, similar to the reversal pattern of the previous multi-year Treasury rallies (Figure 16). Although we're skeptical of a sustained downturn, we still don't like the near to intermediate-term prospects for Treasuries and expect dollar weakness and euro strength to support the trend. For more recent thoughts on Treasuries, see Here
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Despite oil taking its time in plumbing the lows, we still like its long-term prospects relative to US equities and see commodities in general as an asset class outperforming the SPX - as the Fed further normalizes policy. Comparatively speaking, the severe relative strength condition coming into 2015, was in hindsight (see Here), an early indication that the decline in oil would take the better part of the year to fill out (Figure 22).
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Although the Shanghai Composite continues to get lambasted by the media for China's heavy handed response to its swoon, similar to our long-term outlook on Japan, we expect a resumption in the fourth quarter of its outperformance over the SPX into the end of the year. That said, we will continue to keep a close eye on the SPX relative to the Meridian trend line (~1774 for September), to help better shape our long-term expectations for US equities (see Here).

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